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When trouble began in Egypt and crude oil hit $100 (Brent), concern was expressed that the price was getting high enough to limit or even stop the economic recovery in the Western democracies. OPEC ministers assured us at that time that OPEC had spare capacity should the world need it. Indeed, there was plenty of it, some 4 million barrels per day (mbpd). That capacity, however, was being saved for a "major disruption" in oil markets.

Well, now we have a "major disruption" in oil markets.

Indeed, it is harder to imagine a larger disruption than one of OPEC's largest producers, Libya, collapsing into civil war with a near complete cessation of oil exports. Details are uncertain, but it does appear that the bulk of Libya's 1.6 mbpd production has gone off-line.

Now, OPEC tells us that, well, yes, we do have a major disruption, but the excess capacity OPEC actually has is heavy and sour and therefore cannot be readily substituted for the lost light crude previously being produced by Libya.

During previous crises, including the first Gulf War (1990) and the Iraq invasion (2002), Saudi Arabia was able to produce the oil necessary, of whatever grade, to supply world markets. It will be noted, though, that we still ended up with high oil prices and a recession in the West following the first Gulf War.

In 2008, with oil marching toward $148 per barrel, OPEC ministers said the same thing they are saying now. "We have spare capacity, only it is too heavy and sour for current refineries." The result was a price spike to nearly $150 and subsequent economic meltdown.

In other words, we seem to be in precisely the same situation we were in 2008; there is just more of heavy sour available (4 mbpd versus 1) and now we have lost Libyan production to boot. Who knows how long until order will be restored in Libya, and we still have the possibility of unrest spreading to Algeria and other MENA nations.

Meanwhile global demand continues to increase by several hundred thousands of barrels per day each month in China, the rest of the developing world and the OECD.

This combination of increased demand and reduced supply should put Brent well above $150 (very likely as high as $200 a barrel) and sooner rather than later. That would make going long call options on the SPDR S&P Oil & Gas Exploration and Production ETF (XOP) and Oil Service HOLDERS ETF (OIH), as well as the Energy Select Sector ETF (XLE), very profitable trades over the coming months. Going long call options on USO and OIL will probably produce some very nice results as well.

Source: OPEC's 'Spare Capacity': Using ETFs to Manage Libyan Uncertainty